The Optimal Exit Strategy
Boom-er Bust Era
It takes a coordinated Team of Professionals experienced in Mergers &
Acquisitions, Corporate Law, Taxation and Financial Planning / Wealth
Management to successfully execute the Optimal Exit Strategy
Peter Heydenrych
Corporate Finance Associates
setting expectations based on personal
needs and without reference to the
market
failing to explore legitimate positioning
strategies
Buyers of middle market companies don’t
buy jobs for themselves in the way that
small business buyers do, they “invest”
with the expectation of a return
commensurate with the risk. Nothing
enhances a buyer’s perception of value
more than:
The Challenge
evidence of sustainable growth
This past year has been a difficult one for
business owners seeking an exit. Is this the
recession, or a reflection of a longer term
reality? The answer, it seems, is that exiting
business owners will need to engage a new
reality for the foreseeable future.
a capable management team as the key
to managing the risk
According to an article published by Robert
Avery of Cornell University in February
2006, “the majority of boomer wealth is
held in 12 million privately owned
businesses, of which more than 70% are
expected to change hands in the next 10 to
15 years.” Only a portion of these
businesses will successfully cash out,
because of a fundamental oversupply of
sellers.
Key Mistakes Sellers Make
Business owners make a mistake when they
allow too little time to complete a properly
executed exit strategy. Another mistake
owners make is focusing on the price while
disregarding the terms and structure of an
exit transaction.
Other key mistakes business owners make
in exiting their companies are:
selling to the (only) competitor who
approaches them
not using experienced advisors (hoping
to save transaction costs)
The Business owner who engages
professional advisors, plans thoroughly,
and negotiates to ensure that the wealth
transfer mechanism chosen most closely
delivers on his goals, is the business owner
who will have executed the optimal exit
strategy.
Characteristics which
Appeal to Buyers
If the fundamental laws of risk and reward
prevail, only the least risky and most
profitable businesses will change hands
successfully. With buyers focusing on
businesses which represent good
investments capable of operating with little
or no dependence on their owners, the
following characteristics will be seen as
desirable:
Businesses which have scaled beyond a
total dependence on the owner
proprietary products, services or
processes
strong, remaining management
defensible, differentiated market
position
stable, diverse customer base
recurring revenue business model
business growth (opportunities)
strong operating margins
manageable business risk
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The Optimal Exit Strategy
quality business and accounting systems
audited annual and timely internal
monthly financial statements
Defining the Exit
involve inputs from a team of experienced
advisors, and should address the possible
need to re-position the business before
going to market.
Setting Goals
Exiting is more than selling
Exit Planning is a process involving the
development and execution of a series of
systematic steps taken to allow both the
owner and the “accumulated wealth” to be
extracted from the business, via one or
more of the numerous available strategies,
including:
Selling the business to partners, strategic
buyers, investors, competitors,
international buyers, or the public
Recapitalizing the business for partial
liquidity
Merging the business to achieve enhance
valuation and/or marketability
Transferring the business to family,
management or employees
Gifting the business to meet personal
and/or tax planning goals
Liquidating or partially liquidating the
business
Exiting is a process, not an event.
The Optimal Exit will be achieved through
the implementation of a managed process
which includes:
Establishing a business valuation
reference point
Clarifying “Life-after-Business” goals
Working with a team of specialist
advisors
Preparing a written plan
Identifying and evaluating the applicable
alternative strategies (options)
Executing any necessary positioning or
preliminary strategies
Executing the selected exit strategy
Exiting is a complex subject with many
moving parts. No single advisor is an
expert in all aspects, so the process should
Clarifying the Endgame
The Exit Strategy begins with the M&A
Advisor providing a likely range of the
pricing, terms and structure expected from
a sale in the current market. The Financial
Planner or Wealth Manager then develops a
plan to invest the after-tax wealth extracted
from the business to meet lifestyle and lifeafter-business goals.
For the majority of business owners, this
newly liquidated business wealth will
constitute a meaningful portion of the total
wealth driving the financial, tax and estate
plans. The key, then, to beginning the exit
planning process, is to clarify the endgame,
taking into account the likely value of
extracted business wealth.
Legacy Goals – what will have been
your contribution?
Lifestyle and Life-after-Business Goals –
what do you want from the next phase of
your life?
Estate Planning Goals – how will you
ensure that your estate passes to your
heirs in the most tax efficient way?
Exit Strategy Goals – based on all of the
above, what are the priorities to be met
by your selected exit strategy as to risk,
time, wealth and income?
Selecting a Team
Play the “A” Team
The M&A Advisor should assemble and
coordinate a team, including existing
advisors where applicable, that will ensure:
access to all appropriate options and
opportunities
being fully informed as to the merits and
demerits of proposed strategies
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The Optimal Exit Strategy
having expert counsel and representation
The team must include the necessary
knowledge, skills and experience in
Mergers & Acquisitions, Corporate Law,
Taxation and Financial Planning/Wealth
Management. It may also include
specialists in ESOPs, insurance, personnel
and business consulting disciplines.
reconcile the two before selecting and
implementing an exit strategy.
Whether or not the expected and targeted
wealth transfer values are the same, the
owner should review all exit options, and
should also evaluate a number of
Positioning Strategies for execution prior
to implementing an Exit Strategy.
Writing a Plan
Planning Precedes Execution
Business owners should not expect to exit
successfully in the next 10 years without
figuring out how best to exit and what
preparatory steps should be taken. … and
should not assume they can wait until they
are “ready”.
While the critical execution phase will not
be a problem for most take-charge
entrepreneur business owners, the planning
for an exit will be foreign to them as exiting
has never been their purpose. Their purpose
has been to create and build, and to
consider the exit (if at all) a retreat.
Reconciliation or Closing the Gap is an
iterative process of evaluating combinations of positioning and exit strategies
that will yield a release of wealth (the
Expected Wealth Transfer) compatible, as
to quality, time, value and certainty, with
achieving the specified goals and the
associated Targeted Wealth Transfer.
Closing the gap may also involve
modification of the Targeted Wealth
Transfer.
Again, notice that there are two key points
of inflection for matching the exit with the
personal goals:
1.
Reconciling
Expected vs.Targeted
Wealth Transfer
The M&A Advisor should coordinate a
collaborative team effort to prepare a
written Exit Plan incorporating a valuation
of the business, a statement of goals and
objectives, a review of alternative strategies
(options), an analysis of the gap between
the goals and the options, and strategies for
closing the gap.
Reconciling Goals and
Options
Once one has established an indication of
the Expected Wealth Transfer (the aftertax proceeds from the business exit) on the
one hand, and an estimate of the Targeted
Wealth Transfer (the wealth transfer
required to provide the personal life-afterbusiness goals) on the other, the business
owner and the exit team must now
2.
The ability to vary the value, timing
and certainty associated with
extracting the business wealth
The ability to vary the timing, risk
tolerance, estate wealth, living
standards and other variables
inherent in the personal goals
A key issue business owners face in
considering Positioning Strategies is the
very central question of the risk – reward
paradigm. Positioning strategies cannot be
executed entirely without risk, but
manageable risk strategies may deserve
consideration if they serve to better ensure
that the business wealth will be delivered in
the context, amount, time and certainty
needed to meet the identified personal
goals.
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The Optimal Exit Strategy
Positioning Strategies
Corporate Value Enhancement
The team should look at the corporate
structure and governance mechanisms to
consider whether the business is optimally
positioned for the intended exit. For
instance, an asset sale from a C Corp could
result in tax obligations at both the
corporate and the individual levels.
Conversion to an S Corp may be
advantageous, but the tax benefits vest over
an extended period of time.
The make-up of the Board and any
Advisory Board may also have an impact
on the value perceived by a buyer.
Management strength is considered below.
From the standpoints of scale, product or
market diversity, management strength or
any number of others, the business may
benefit from a combination with or
consolidation into another business prior to
its sale. Alternatively, it may be desirable to
spin-off one or more non-synergistic or
non-performing divisions to increase
profitability or allow greater management
focus.
Business Value Enhancement
Business value enhancement strategies
generally influence valuation because of
their perceived impact on risk, growth or
profit margins. At the top of many buyers’
lists is the need to see a strong, experienced
and motivated management in place. For
financial buyers, this often includes the
need to be assured that management has
skin in the game, typically an equity
interest.
Improvements in profit margins are
strongest when they are reflected in trailing
(historical) earnings. More recently effected
changes, or even planned changes, can also
influence valuation, however, if the benefit
of the changes can be quantified and
demonstrated. Because of the multiplier
effect built into earnings-based valuations, a
$1mm earnings improvement may increase
the valuation by, say, $5mm.
It doesn’t seem entirely logical that an
exiting business owner would have
unexplored opportunities available for
making improvements to the business. It’s a
little like living with an outdated kitchen
and upgrading just before selling the house.
As in the real estate analogy, the stakes are
higher at the time of exit, and the focus on
marketability and valuation greater, so
these opportunities often do exist.
Other business value enhancement
strategies include:
Reviewing and revising the revenue
and/or business models
Implementing product / market
enhancement plans
Expanding and diversifying the
customer base
Securing title to patents and intellectual
property
Commissioning of financial and
operational audits
Strengthening or upgrading of systems
and procedures
Documenting or codifying contractual
relationships (employees, vendors,
customers, debt)
Business Marketability Enhancement
If growth opportunity, managed risk and
strong margins are the foundation for
building value enhancement strategies, then
clarity, transparency and certainty are the
engines which drive marketability.
Business performance is clearly reported
and accounted for, activities and status are
transparent to the buyer, and all information
portrays a level of certainty about the
future.
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The Optimal Exit Strategy
Experienced buyers know that completing
acquisitions is a time-consuming and
expensive exercise. Buyers will perceive
greater clarity, transparency and certainty,
and therefore be more motivated to engage,
when the seller has:
Audited financial statements
A business plan with a clearly defined
growth path
An in-place sector-experienced
management
Current market metrics and analysis
Multi-Step Liquidation Strategies
Reference is made above to the risk-reward
paradigm. This fundamental reality plays
out in ways too numerous to mention,
including strategies elected by business
owners to both take cash off the table to
reduce risk/exposure as in a re-cap, and
assume reasonable risks for an enhanced
valuation as in an earn-out structure.
Consider:
The lowest price is an all cash price (not
often available in today’s market)
Waiting before selling is risky
Participating in an industry
consolidation or roll-up increases the
risks and uncertainty of an exit, but
potentially enhances marketability and
yields a greater valuation
A classic two-stage exit is accomplished by
means of a re-capitalization in which an
investor / partner / buyer acquires part of
the business with an expectation to either
buy the rest of the business or to market the
business in cooperation with the remaining
owner at a later time and at a greater
valuation. The owner takes some chips off
the table, but retains a stake, and usually
continues to participate in management.
Merging the business into one or more
other businesses before exiting can lead to
increased marketability and even an
improved valuation sometimes referred to
as multiple bump. Consider a $20mm
revenue business with earnings of $3mm
which commands a valuation of $15mm (or
a 5 multiple). Combining that business into
a $100mm business with earnings of
$15mm and which commands a valuation
of $90mm (a multiple of 6), now values the
original company’s participation at $18mm,
and the consolidation strategy has yielded a
$3mm valuation gain.
Transaction Structuring Strategies
Every step along the complex path of
executing an exit strategy demands access
to advice from professionals who have been
there and who know the opportunities and
the pitfalls.
Even though the structuring of the exit
transaction comes toward the end of the
process, structuring is included here as a
positioning strategy because it impacts the
value of the Expected Wealth Transfer.
Key structuring considerations include:
Considerations of risk and reward
Tax considerations
What incomes and expenses are included
(i.e. belong to the transacted business)?
What assets and liabilities are
ex/included
What pre-transaction liquidation,
settlement/exclusion opportunities exist?
What relationships between buyer and
seller arise? (employment, advisory,
landlord, supplier, partners, etc.)
Documenting or codifying contractual
relationships (employees, vendors,
customers, debt)
The majority of middle-market businesses
bought and sold derive their valuation, at
least in part, from cash flow or earnings.
The very key question then arises: “What
assets and liabilities are essential to and an
integral part of the ongoing enterprise,
thereby supporting the established earnings
flow?”
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The Optimal Exit Strategy
Exit Strategies
Benefits of a Planned Exit
The business owner should have his M&A
Advisor prepare an analysis of the fit and
applicability of each of the exit strategy
options to the stated goal and objectives.
Not all options will fit every business or
every set of goals.
The primary purpose of approaching a
business exit in a systematic, goal-focused
and planned way is to dramatically increase
the likelihood that the outcome will be
optimal to the stated goals.
Key qualifications for individual strategies
might include:
Strategy
Buyer
Qualifications
Sale
To Partners
Available funding
To Competitor
Manageable confidentiality; synergy; certainty of close
To Strategic Buyer
Synergy; identifiable business purpose
To Financial Buyer
Management; financial performance
To International Buyer
Scale/size; international orientation
To the Public
Scale; integrity; prospects
Re-Cap
Growth; Cash flow; leveragability
Merge
Target(s); strategic fit
Transfer
To Family
Capability of transferee
To Management
Management strength; commitment and buy-in
To Employees *
Management; market strength; leveragability
Gift *
Personal goals
Liquidate
Modest or negative return on assets
The employment of a team of professional
and experienced advisors will add a cost of,
say, 3% - 6% of the wealth transferred, but
will potentially add considerably more
value by:
mitigating against a failure of the
mission
dramatically expediting the mission
Intermediating the process to eliminate
the risks associated with direct
negotiations between principals
increasing the negotiated value of the
mission
reducing the income tax burden
helping to reconcile the Expected
Wealth Transfer to the Targeted Wealth
Transfer
… not to mention providing the knowledge
and human resources to navigate a complex
and time-consuming labyrinth of decision
making and task execution.
* Specific qualifications must be met as preconditions to accessing the designated tax benefits.
Corporate Finance Associates
24461 Ridge Route Drive, Suite A200
Laguna Hills, CA 92653
T/ 949.305.6710
E/ [email protected]
W/ www.cfaw.com